Seizing Mortgages: The Eminent Domain Power & Mortgage Foreclosures
Eminent domain power allows a governmental body to seize property for the greater public good. Foreclosure is a legal process where a lender attempts to recover the loan balance of a borrower by forcing the sale of the asset used as collateral for the loan. Two seemingly different concepts have been widely discussed in recent months. Why and how are they related?
A few cities across the country have considered using the eminent domain power to fight the housing crisis. The housing crisis continues to affect cities across the country and, particularly, those cities already poor and struggling. Median home prices in these cities have dropped to half of what they used to be at the height of the housing boom. Many houses are thus “underwater;” that is, more money remains on the loan than the current price of the home. Homeowners in these situations have often walked away from their homes, unable to continue paying mortgage payments and unable to sell a home worth less than the loan.
Recently, cities such as Pomona and Richmond in California have considered the use of eminent domain to combat this problem of underwater mortgages. Under the plan, the city would use its eminent domain power to seize troubled mortgages from investors who currently hold them. A company working with the city would then restructure the mortgages and refinance them with the homeowners.
Here is how it will work:
- City identifies mortgages that are underwater.
- City first offers to purchase these mortgages from the mortgage owners.
- If the mortgage owners do not agree to sell, the city uses its eminent domain power to seize the mortgage paying fair market value for it, rather than the “pre-bubble” face value of the mortgage.
- The city works with a private company to finance the city’s acquisition of the underwater mortgages.
- The city refinances the loans through the Federal Housing Administration and writes down the principal. The mortgage is restructured on behalf of the homeowner so that the monthly mortgage payments are affordable.
- The house is no longer underwater and the homeowner can afford the monthly mortgage payments.
Richmond appears to be the closest city to move forward and implement this plan. In September 2013, its City Council voted to move forward with the initiative. Most recently, Irvington, N.J. announced that it is proceeding with a legal study of the plan. Other municipalities, such as San Bernardino County in California and North Las Vegas have rejected similar proposals.
While this plan may work in theory, there are several legal and practical issues that cities like Richmond will inevitably face if underwater mortgages are seized using the eminent domain power. In fact, a group of banks has already filed a lawsuit against Richmond seeking an injunction. The lawsuit alleged: (1) the city cannot properly seize the loans because the plan does not meet the public use requirement for a government taking and (2) the plan would “wreak havoc” on the value of mortgage-backed securities and harm investors.
U.S. District Court Judge Charles Breyer dismissed the banks’ motion for an injunction without prejudice. He found that the case was not legally ready for court, since the requested injunction rested on future events that have yet to occur.
Thus, until cities like Richmond actually begin seizing underwater mortgages, banks and other organizations will have to wait to begin legal action.